Cornwall Stodart Tax Digest: March 2010

Introduction

A recent case heard by the Administrative Appeals Tribunal
(Tribunal) highlights the importance of taxpayers
being able to supply evidence demonstrating the commercial
rationale for discounts offered on supplies.

This is of particular importance where discrete items comprise a
supply (mixed supply) that contains a GST-free component. A mixed
supply occurs where two or more items comprising a single supply
are significant in their own right and one of the items is GST
exempt. This contrasts with the position where a GST-exempt
component of a supply is 'ancillary' to the provision of the other
significant item or items representing the supply (composite
supply). The A New Tax System (Goods and Services Tax) Act
1999 (Act) does not define the meaning of
composite supply; however the Commissioner of Taxation
(Commissioner) accepts that composite supplies
arise. Where GST-free items are ancillary, and therefore a
composite supply to the main supply, the taxpayer would not be
eligible for relief under the apportionment provision contained in
s9-80 of the Act.

The Case

In Luxottica Retail Australia Pty Ltd v FCT 2010 ATC
10-119 (Luxottica), a supplier of
prescription eyeglasses (Taxpayer) was assessed to
GST under s9-80. This provision requires that the price of the
supply is apportioned between the taxable supply and that part
which is GST-free, so that GST can be levied on the taxable
component. Prescription lenses (medical devices) are GST-free. A
discount offered on the frames was conditional on their purchase
being made in combination with the prescription lenses which were
not discounted. The discount arose as a consequence of a
promotional offer the taxpayer offered from time to time.

In calculating the apportionment, the Commissioner ignored the
discount on the frame price; in s9-80, the 'value' (taxable value)
to be placed on the taxable supply is not a defined term for the
purposes of this section. This had the effect of increasing the
value of the supply that was subject to GST. The following example
illustrates the point.

Assume the undiscounted price of the frames was $200 and the
lens price was $100. After the discount of $100 (which related
exclusively to the frames) the price paid by a customer for the
spectacles was $200. For the purpose of working out the taxable
value that was subject to GST, the Commissioner applied the
following calculation:

$200/$300 = 66% (The Commissioner
attributed the undiscounted price as the 'value of the taxable
supply' of the frames to determine the relevant proportion that
they represented of the supply).

The 66% was then applied to the actual price for which the goods
were sold to determine the taxable value on which to levy GST; ie,
$200 x 66% = $132.00 x 10% = $13.2 GST.

By contrast, if the value of the taxable supply was calculated
using the actual price paid by a customer for the items, the result
would produce a lower taxable value component of the value of the
supply on which GST would be levied, as is demonstrated by the
following (note: s9-80 applies some additional factors which have
been disregarded for these purposes but which do not materially
affect the result):

$100/$200 = 50%

50% x $200 = 100 x 10% = $10 GST

If the Commissioner's approach was adopted the GST payable would
be increased by $3.20 (ie $13.20 - $10 = $3.20).

The Commissioner argued that the discount only occurred as a
consequence of the conditionality requiring both the frames and
lenses to be purchased together, and therefore the discount should
be ignored for the purpose of valuing the taxable supply. (If this
submission had been successful, it would have had the effect of
imposing GST on a portion of an otherwise GST-exempt item.)

The Tribunal was unable to determine the exact basis for the
Commissioner's argument. The Tribunal said:
'[t]he…[Commissioner] argued strenuously that the
conditionality issue brings about the result for which the
Commissioner contends but he did not explain why this conclusion
follows, and we do not accept that it is so'.[1]

The Taxpayer argued that the frames were separate to the lenses
and should be taxed under s9-75, as they had become fashion items.
Although clients purchased new lenses, that purchase was incidental
to the purchase of the frames, which was unconnected to a client's
need for corrective lenses.

Importantly, as it was possible to buy frames and lenses
separately, the Taxpayer argued that each should be treated as a
separate supply. Ultimately such matters turn on their facts and
the Tribunal, while noting that frames were fashion accessories,
concluded there was only one supply and that s9-80 operated in the
circumstances. However, the Tribunal found that commonsense
dictated the taxable value proportion of the supply was to be
calculated by dividing the discounted frame price (less GST) by the
actual selling price of the complete pair of spectacles (less
GST).

In reaching its conclusion the Tribunal took the following
factors into account:

there were sound commercial reasons for discounting the
frames;

there was no commercial imperative for discounting the lenses;
and

there was nothing contrived or artificial about the pricing
methodology adopted by the Taxpayer in its promotional
arrangements.

The Commissioner also argued that this case was not
distinguishable to that of Re Food Supplier and
FCT[2] (Food case). There, the
sale of food hampers (uncooked food being GST-exempt) which
contained a promotional mug was held to be a mixed supply and
required a value to be attributed to the mug (a non-exempt item
under the Act) so that GST could be levied. It was found that the
food product was being sold at an excessive discount, with no value
being attributed to the mug. This conclusion was reached because
the promotional item could only be purchased from the taxpayer with
the food and the taxpayer would not separately provide the mug free
of charge.

While the outcome in the Food case is arguably correct,
the decision of the Tribunal here does not explain why the
Commissioner determined the Food case justified the
approach he adopted for Luxottica. The Commissioner may
have considered that, as the apportionment of the undiscounted
value of the mug in the Food case was used to determine
the apportionment under s9-80, this justified the taxable value for
present purposes being the undiscounted price of the frames.

However, the Tribunal distinguished the Food case and
found that '[i]n this case [Luxottica] there were two items or
components and in respect to each of those components there was an
agreed price which was in no way artificial or
contrived". [3] In other words, the Taxpayer
sold the frames and the lenses in the marketplace at separate and
distinct prices that could be commercially justified. The discount
could also be clearly attributed to the frames because there was no
commercial imperative to discount the lenses.

Comment

Taxpayers will need to ensure that, if a discount is offered in
respect to a mixed supply which includes a GST-free supply, they
can prove (as noted by the Tribunal) that:

there are sound commercial reasons for discounting an
item;

where only one of the items is discounted, there is a
commercial justification to support the non-discounting of the
other item; and

there is nothing contrived or artificial about the pricing
methodology adopted by the taxpayer in respect of the
arrangements.

If these factors cannot be demonstrated, the Commissioner is at
liberty to ascribe a value to the taxable portion of the supply as
he thinks appropriate. Clearly this could have significant
consequences for the competitiveness of the particular supply in
the marketplace.